Keep your powder dry

John Gorman, Macquarie University: Rather than carry exposure to funding from a single source, recent debt was raised from several sources – $200 million from several banks and $250 million on the capital markets. Photo: Sasha Woolley

Shaun Drummond

Jeff Forbes, Cardno: The company abandoned its first US placement – as buyers in the market became nervous – for a better deal locally.
Photo: Glenn Hunt

Exposure to debt has returned as a concern in 2012 for larger companies seeking access to finance. So what do you need to do to minimise risk and get the best deal?

Brisbane-based engineering firm Cardno is one of a number of companies that was forced to change tack and abandon a private placement raising in the United States when markets went crazy after the US credit downgrade in August, and further European sovereign debt crunches that followed.

“We didn’t go ahead because the world changed,” chief financial officer Jeff Forbes says. “The buyers in the market got a little nervous and the margins increased and we were able to do better deal [elsewhere].”

The price rose rapidly, but lucky for Cardno it had banks knocking on its door, and a club loan provided a better deal.

Forbes had been scoping the market for options to increase and extend the company’s debt facilities when existing facilities expired. Cardno had grown bigger, so as it increased the number of banks lending to it from one – HSBC – to four, adding Westpac, National Australia Bank and Commonwealth Bank, the club loan fitted the bill. That doubled its borrowing to $265 million and extended average maturity to five years from three. It also obtained a mix of US dollars, sterling and Australian dollars.

Cardno has been growing via acquisition offshore, and debt is the primary option to fund that with targets taking equity alongside itself. Many of its acquisitions are in the US, so a US private placement would have been ideal.

Debt first

The need to shore up debt funding in case things turn nasty again is the prime concern for companies large and small. Many already have big cash reserves and are hard at work on the working capital levers, but the chief lesson of the past three years is that, even if you don’t need it, you should keep your lines of communication open with investors – debt and equity – and keep your fund-raising machinery ready to take advantage of opportunities.

Angus McKay, CFO of freight and ports company Asciano, found some French banks conspicuously absent when the company did a $1.44 billion bank debt refinancing via a syndicate in October. While the pricing was significantly better than for the facility it replaced, if he’d done it any later prices would have worsened. As European banks pull out and bank credit ratings are downgraded, he says there’ll be fewer lenders Asciano will be prepared to settle with.

“It’ll tighten around who lends to you and who you’ll transact with,” he says. “You get this book end squeeze, with the banking world becoming far tighter, with far fewer counterparties of the same quality.”

Diversity of financiers and keeping options available is now fundamental. Cardno’s club arrangements are one example. Akin to syndicates, these usually suit smaller amounts and each bank provides its own terms and conditions, rather than a combined offering. They became popular during the global financial crisis when banks were unwilling to lend large amounts, but they also help reduce risk of exposure on both sides of the transaction.

Just over a year ago Macquarie University finance chief John Gorman was the first to take a local university to the bond markets. He wanted to borrow to finance plans for developing new revenue streams from rents from related research organisations the university aimed to attract to co-locate on its campus. It had already done something similar with a private hospital, and Cochlear’s headquarters are in its grounds.

Despite the education sector’s troubles with a high Australian dollar, the university could have raised the total $450 million of debt it was seeking from a single bank – such was the demand for a firm with guaranteed long-term cash flow from government coffers, which makes up about a quarter of its funding. But the risk was too great.

“The banks would have lent all of it, but we decided to allocate $100 million to each of the banks, then raise the rest on the capital markets. That ensures less credit exposure [to a single source].”

Planning for speed

Like many resources operations, Sydney-based Oil Search is not short of cash with about $1 billion on hand. It is Papua New Guinea’s largest oil and gas producer, with a 29 per cent stake in the PNG liquified natural gas project which is due to start exporting in 2014. It also plans to invest in new projects and to refinance a $263 million liquidity backstop of undrawn debt facilities as a contingency that it needs to refinance shortly. That is secured to its oil assets, which means it is naturally amortising, with the value available reducing over time. It is keen to replace that with a five-year, non-amortising facility reflecting the company’s changing credit profile and new cash flows coming on stream from the gas project.

CFO Zlatko Todorcevski says the company is evaluating the potential for a stand-alone LNG project of its own along with opportunities in the Middle East and Africa. These investments would be funded through internal cash generation and, if required, additional debt.

The tricky part is choosing which source is the right one when conditions change so quickly. “We’ve spent a lot of time doing detailed scenario modelling so we could really understand how various options would play out,” Todorcevski says. He stresses they’re not “trying to guess where the world is going to go. It’s about what the givens are and the no-regrets decisions we can take today that really don’t close down any options.”

The refinancing of Oil Search’s corporate facility is an example of a no-regrets decision. “Under every scenario there’s no regret in replacing it with something that is non-amortising and beyond the start up of LNG production,” he says.

Beyond that, he says the scenario planning helps the company to “set the milestones coming up over the next 12 to 18 months that will give us key information about what the potential growth options will look like and the timing”.

By doing that work, it can identify what information is missing and what the trigger points are, which will allow it to make a final decision as more data flow in. “It’s about understanding what those milestones look like, the potential outcomes in each of those scenarios and thinking through what we need to do today should a certain scenario pan out,” he says.

Further funding decisions will require more information on the timing and size of those potential investments. “We’ve looked at everything from convertibles to trying to understand the high-yield bond market in the US to determine what might be a good fit for us and what preparatory work we might need,” he says. “If we decide in 2012 or ’13 we need to do some kind of follow-on exercise, we’ll be ready.”

Ultimately, all of those different options will involve a trade-off between price, terms and flexibility. “When you’re looking at bank lending or capital market opportunities, it really comes down to timing and how the terms and price coincide with the availability of opportunities,” he says. “As we’ve seen over the past couple of months, the market isn’t very open or receptive. If you’re forced to go to market at that time you’ll get a sub-optimal outcome.”

Oil Search also needs to consider the pros and cons of each option for the longer term. It would be a first-time issuer in the high-yield bond market, which might limit the terms and pricing it receives compared with other options. “But with the amount of volatility, you really can’t take it for granted that your long-term banks will always be there, or the capital market options,” he says.

Doing a bond issue would give investors familiarity with their company, he says, “potentially giving us some advantages as we go to future funding exercises in the next five to 10 years”.

Goal posts move

It has been a tough couple of years for Bendigo and Adelaide Bank. Even more so than the major banks, it has had to slew its funding base to deposits, which now sit at about 75 per cent of the total, up from around 60 per cent. Securitisation of loans and short-term wholesale funding make up the rest.

The latter has, however, shrunk to 7 to 8 per cent as Bendigo’s BBB+ rating has closed this option off, apart from a recent bond issue to retail investors.

For most of 2011, the bank was intent on raising its credit rating, and S&P was the last of the major credit rating agencies to raise them to A- in early December. Unfortunately it hasn’t been able to put its upgrade to much use when even the AA-rated big banks have been shut out of wholesale markets. But it gives it more options to obtain cheaper funding tailored to its needs.

When the time is right, CFO Richard Fennell says Bendigo will use its upgrade to expand its short-term wholesale funding. He is hoping investors will be keen this year to diversify away from the majors which have dominated wholesale issuance on the domestic market since the GFC.

Pricing of course is key. If spreads are above 160 basis points over the bank bill swap rate, it gets too expensive for its needs. Its securitisation is now about 17 per cent of funding. To diversify its funding base and keep the cost of capital to a minimum in a competitive marketplace for term deposits, this is where it has been most active to-date.

Bendigo has continued to rely on some support from the Australian Office of Financial Management, which is responsible for Australian government borrowing, to buy some of the tranches of its securitised mortgages. But it has also tailored part of its RMBS issues to take into account the investment mandates of super funds. Last year it also issued specifically to Japanese yen investors as well as issuing a bond to retail investors locally.

Fennell says the company won’t reduce the proportion of funding from deposits but it may reduce the amount of wholesale funding it sources from securitisation with the new credit rating. Part of the reason for that is to make sure it has access to alternative sources when it needs it. “In term wholesale funding – we want to be active in the market,” he says. “Not necessarily being out there every month, but at least have our name out there so if we need to access [a deal] quickly there are investors who are familiar with [us] as an issuer and that provides more ready access to funding.”

Securitisation can take up to six weeks to arrange and source, whereas once investors are familiar with an issuer, a deal can be done on the term funding markets in a few days. In addition, while deposits are a cheap funding source in normal times, they and securitisation are much more expensive than issuing debt, Fennell says. “If there was an opportunity that required us to fund something quickly, then having three strings to our funding bow rather than being reliant on our deposits [helps].” However, deposits will continue to be Bendigo’s primary source of funding.

Hard bargain

Since the GFC, more boards and finance chiefs have sought independent advice, to avoid being railroaded into a deal that ensures good fees for bankers but may not be in their own best interests. Many see the extra cost as a safeguard that saves money in the long run.

Boards have also become very keen on having another set of eyes involved. Much, however, depends on how frequently deals are done – some who access funding regularly for growth will often have a tried and true strategy and an experienced in-house team for making those funding decisions.

However, Macquarie University’s Gorman says despite many years raising money for private firms, they hired an independent adviser – Grant Samuel – for the $450 million bank loan and bond issue.

He says they more than paid for themselves. “You’re always better off having independent advice,” he says. “Really, they more than paid for themselves by what we saved.” For instance the deal included no-debt covenants – though Gorman says they would probably have agreed to debt covenants if they had been negotating with the banks on their own.

Grant Samuel had already advised the university on a capital restructure and it made sense to keep them on to advise on the correct funding options. But Gorman says you always need to keep something back and have the correct incentives for any advisers.

“We went to market seeking $200 million, but we always wanted $250 million,” he says. Similarly, the price they were prepared to pay for that debt was kept a secret from the advisers. He had a range in mind of 170 to 220 basis points above the bank bill swap rate, based on issues of banks and other similar rated organisations in the previous couple of months. But only he and the vice-chancellor, Steven Schwartz, knew of the lower figure. This was to ensure their adviser strove for the best price possible, and was motivated to do so.

“You can use a fixed fee for service or give them a fee which is based on outcomes,” he says. “So if they can achieve a benchmark [within] this level you get paid [a base fee]. If you achieve better than that, you get paid more.”

But much depends on your bargaining position and how much banks and debt investors are keen to lend to you.

Similarly Cardno’s Forbes says he wanted a minimum of two banks, but four reduced the company’s counterparty risk even further. Fortunately the banks had been interested in lending to them for some time, which put them in a stronger position.

“That was an interesting exercise,” he says. “We didn’t provide the covenant definitions. [Instead] we said these are the covenants we’ll accept. We wanted to see what [they came up with].”

For smaller companies, funding options are a mixed bag that includes angel investors, private equity and banks. Further down the scale, there are government grants and, at the very early stage, “friends, family, fools and followers”, as one small company funding adviser puts it.

That early stage, however, now holds much more potential thanks to the internet and the phenomenon of crowd funding, which is getting a new lease of life due to legislation passing through the US Congress to ease restrictions on raising finance directly.

Australia already has the Australian Small Scale Offerings Board (ASSOB) that allows up to $5 million to be raised without a prospectus, but it is limited to 20 investors. Crowd funding, however, relies on many people putting in small amounts. Offering shares this way is not allowed under Australian law, so most sites, including Pozible, which has been operating from Melbourne for several years, and Powerup, which just started in Sydney, give small rewards instead, like free use of the first product produced.

In Britain, equity stakes are allowed and as a result much larger sums are raised. One British start-up raised £1 million recently via Crowdcube.

Yanese Chellapen, director of small business adviser Pennam Partners, which is starting up a venture capital fund here, is an advocate for reducing restrictions on this source of funds, and for offering government incentives to help established businesses raise funds more easily.

“Crowd funding, while it’s not an answer by itself, would assist businesses in the $0 to at least the $1 million range to raise cash,” he says.

There are many other possibilities already in place in Australia, however. As well as ASSOB, there are various government schemes to encourage investment, including the Early Stage Venture Capital Limited Partnership, which allows investors in registered venture capital firms to claim tax exemption for dividends. Companies with assets of less than $50 million can access these investments.

There are also grants available. However, Chellapen says the government “should be doing more to invest or co-invest cash in micro and small businesses either as an equity participant or as a loan”.